Background:
Generally, Indian listed companies come up with the grant of ESOP after appraisal month, i.e. May/June. It helps to align rewards with recent performance of the employees. However, challenges arise in determining ESOP cost due to various factors like market volatility, vesting period and regulatory & tax considerations. Despite these challenges, careful consideration of valuation methods like the Black-Scholes model and close adherence to regulatory guidelines can help navigate the process effectively.
When a listed company undertakes a share-based payment transaction, the fair value of the stock options of the company is guided by the IND AS -102 which provided various methods to determine the Fair Value out of which the most popular method adopted by the Valuers is “Black Scholes” to be applied to measure the Fair value of the services be reference to the fair value of the Equity instrument granted the time of Grant of Options.
Let’s try to understand the various market driven factors which are important to be considered at the time of determination of the Cost at the time of Grant.
What factors affect at the time of determination of the ESOP Cost:
Black-Scholes Model for Fair Value of Options: As on grant date, fair value must be calculated as per Ind AS-102 using the Black Scholes Model which is one of the popular methods.
Irrespective of the method adopted as per INDAS 102, Option pricing model considers the following factors:
- Exercise price of the option;
- Life of the option;
- Current price of the underlying shares;
- Expected volatility of the share price;
- Dividends expected on the shares; and
- Risk-free rate of interest for the life of the option
It is pertinent to understand that the valuation of shares is not an exact science and ultimately depends upon several factors including the purpose of valuation, stage of business, and % of discount at which shares to be valued, etc.
Need for determination of ESOP Cost for accounting purposes:
- Expense Recognition over Vesting Period: The fair value determined by the Black-Scholes model is expensed over the vesting period of the options. This ensures that the cost of the ESOP is accurately reflected in the financial statements, distributing the expense across the period during which the employees earn their rights to exercise the options.
Determination of Exercise Price at the time of Grant:
- Flexibility in deciding the Exercise Price: The SBEB & SE Regulations 2021 clearly allow the Companies to freely decide upon the Exercise Price of ESOPs, at the time of Grant.
Conclusion:
Indian listed company which are planning to grant ESOPs but struggling with determining the ESOP cost, need to keep in mind the time of determination of Valuation at the time of Grant and careful consideration of valuation methods by the independent valuer like the Black-Scholes model is essential.
